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Costa Rica Politics April 2018

Costa Rica: Carlos Alvarado elected president on 1 April, can he bring the fiscal deficit down?

April 1, 2018

Carlos Alvarado of the incumbent Citizen’s Action Party won the second, decisive round of Costa Rica’s presidential elections on 1 April, winning approximately 60% of the total vote. He beat Fabricio Alvarado of the National Restoration Party and will take over from President Luis Guillermo Solís on 8 May. The president-elect has placed two issues at the forefront of his economic agenda: Reducing the large fiscal deficit and shoring up growth. Economic growth in Costa Rica was lackluster towards the end of last year, heavily weighed down by falling fixed investment on the back of political uncertainty and higher interest rates. Moreover, the country’s fiscal deficit grew to 6.2% of GDP in 2017—the largest on record—following years of insufficient legislative efforts to bring it down.

The president-elect has stated that he aims to reduce the deficit to 3.0% of GDP by 2022 through measures such as the imposition of a fiscal spending rule, constraining government current expenditure levels, and transforming the current sales tax into a Value Added Tax with a greater amount of taxable goods and services, while leaving the tax rate itself at 13%. He hopes these efforts would make the Central Bank inclined to hike the policy interest rate less in the future—it last hiked the rate on 31 January—partly because his government would have to borrow less from local capital markets. Carlos Alvarado has also outlined additional growth-enhancing measures, such as completing the country’s entry into the OECD; establishing greater incentives to higher workers with disabilities, thereby strengthening and widening the labor force; and promoting the science and technology industries.

If effectively enacted, Alvarado’s agenda should go some way to improving the economic outlook. However, when he takes up office on 8 May, the president-elect’s party will only have 10 out of 57 elected representatives in the Legislative Assembly. As such, just how much of his agenda is enacted will depend on the extent to which his party can compromise with others in the Assembly.

As Joao Pedro Ribeiro, Research Analyst at Nomura, noted, Alvarado’s party has a “recent track record of only very modest success in fiscal measures” in the Assembly. Moreover, his party’s electoral reliance on trade unions and public-sector workers also limits the political room he has for expenditure cuts. But, while legislative compromise is certainly not guaranteed, there is reason for optimism. The recent fast-tracking of a fiscal policy bill through the Assembly was an example of exactly such compromise. Moreover, Alvarado may form a government comprising politicians from different political parties.

Notwithstanding the recent elections, the Central Bank expects the economy to grow 3.6% in 2018 and 3.9% in 2019. The analysts FocusEconomics surveyed this month, meanwhile, forecast an expansion of 3.5% in 2018 and 3.7% in 2019. In terms of Costa Rica’s fiscal balance, our analysts pencil in a deficit of 6.7% of GDP for both 2018 and 2019.

Consumer prices fell 0.1% in August compared to the previous month, contrasting the 0.7% jump in July, which was a three-and-a-half year high and due to the introduction of an expanded VAT in the month.

Annual economic growth in cyclically-adjusted terms inched up to 1.5% in June from May’s revised 1.4% (previously reported: +1.3% year-on-year), which represented the weakest reading since December 2009.
Growth remained historically subdued in June due to a continued decline in activity in the agriculture sector, which is struggling following a prolonged spell of dry weather, partly due to the El Niño effect.

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